What Is Green Investing and How Does It Work?
Green investing aims to support business practices that have a positive environmental impact. Green investments, which are often grouped with socially responsible investing (SRI) or environmental, social, and governance (ESG) criteria, focus on businesses or projects that are committed to natural resource conservation, pollution reduction, or other environmentally conscious business practices. Although green investments fall under the SRI umbrella, they are more specific.
To support green initiatives, some investors purchase green bonds, green ETFs, green index funds, green mutual funds, or stock in environmentally friendly companies. While profit is not the only motivation for these investors, there is some evidence that green investing can match or even outperform traditional assets in terms of returns.
Green Investing: An Overview
Green investments that are pure-play are those that derive all or most of their revenues and profits from green business activities. Green investments can also refer to businesses that have other lines of business but focus on green initiatives or product lines.
There are numerous opportunities for businesses seeking to improve the environment. Some green businesses are researching renewable energy or developing environmentally friendly alternatives to plastics and other materials. Others may seek to reduce pollution or other environmental impacts from their manufacturing processes.
Because there is no universally accepted definition of “green,” what constitutes a green investment is open to interpretation. Some investors are only interested in pure-play options such as renewable fuels and energy-saving technology. Other investors put money into companies that have good business practices in terms of how they use natural resources and manage waste, but they also generate revenue from a variety of sources.
Green Investing Types
There are several options for investing in green technology initiatives. While once thought to be risky, some green technologies have proven to be profitable for their investors.
Buying stock in companies with strong environmental commitments is perhaps the most basic form of green investing. Many new start-ups are attempting to develop alternative energies and materials, and even established players are betting big on a low-carbon future. By focusing on environmentally conscious customers, some companies, such as Tesla (TSLA), have been able to achieve multi-billion dollar valuations.
Investing in green bonds is a second option. These fixed-income securities, also known as climate bonds, are loans that help banks, companies, and government bodies finance projects that have a positive environmental impact. The Climate Bonds Initiative estimates that $290 billion in green bonds will be issued in 2020. 1 These bonds may be eligible for tax benefits, making them a more appealing investment than traditional bonds.
Funds for the Environment
Another option is to buy shares in a mutual fund, exchange-traded fund, or index fund that invests in green companies. Rather than investing in a single stock or bond, these green funds invest in a basket of promising securities, allowing investors to spread their money across a diverse range of environmental projects.
TIAA-CREF Social Choice Equity Fund (TICRX), Portfolio 21 Global Equity Fund Class R (PORTX), and Green Century Balanced Fund (GCBLX) are just a few examples of green mutual funds. 2 Several indexes also try to track businesses that are environmentally friendly. The NASDAQ Clean Edge Green Energy Index and the MAC Global Solar Energy Index, for example, are both focused on the renewable energy sector. These indexes are followed by 34 funds that invest in renewable energy companies, allowing investors to support new technology while potentially profiting.
Green Investing’s Outcomes
Green investing, which was once considered a niche sector, has grown in popularity as a result of several natural disasters that have drawn attention to the impending climate crisis. The amount of new money invested in ESG funds reached $51 billion in 2020, more than doubling the previous years
Although profit is not the only goal of green investing, there is evidence that environmentally friendly investments can match or outperform more traditional assets in terms of profitability. Morningstar, Inc. discovered in a 2020 study that there is “no performance trade-off” between environmentally sustainable funds and the overall market. According to the study, “the majority of sustainable funds have outperformed their traditional peers across multiple time horizons.”
Investing in “green” companies can be riskier than other equity strategies because many of these companies are still in the development stage, with low revenues and high earnings valuations. Green investing, on the other hand, can be an appealing way for investors to put their money to work if encouraging eco-friendly businesses is important to them.
The term “green” can mean different things to different investors. Some so-called “green” funds invest in companies that produce natural gas or oil. Despite the fact that these companies may be researching renewable energy technology, some investors may be hesitant to invest in a fund associated with fossil fuel companies.
Prospective investors should conduct due diligence on their investments (by reviewing a fund’s prospectus or a stock’s annual filings) to determine whether the company meets their definition of “green.”
Investing in the environment vs. Greenwashing
The practice of branding a company or product as “environmentally friendly” in order to capitalise on the growing demand for sustainability is known as “greenwashing.” While green marketing is frequently sincere, many businesses have exaggerated the impact of their environmental practices or understated the environmental costs of their products.
For example, some companies have overstated their use of recycled materials, leading consumers to believe that their products were more environmentally friendly.
Many businesses buy carbon offsets to reduce their carbon footprints, but determining the true cost of a company’s emissions is difficult. IKEA was accused of using illegally sourced wood in some of its furniture products in a more egregious case. Worse, the timber had been verified by the Forest Stewardship Council, raising ethical concerns about the pay-for-play green labelling business model.
Some managed funds in the securities industry have tried to greenwash themselves by rebranding in a way that suggests a higher level of sustainability. The only way to determine a fund’s long-term viability is to look at its assets.
What Are Some of the Best Green Stocks to Invest In?
While there is no surefire way to predict a stock’s future earnings, renewable energy generation and storage has been one of the most successful green investments. Tesla’s stock, for example, has increased by more than tenfold between 2018 and the middle of 2021. 9 LONGi Green Energy Technology, a Chinese company, saw its market capitalization rise from $11 billion to nearly $70.5 billion during the same time period.
Are Green Investments a Good Investment?
While profit is not the only goal of green investing, there is evidence that green investments can match or even outperform traditional assets in terms of profits.
Morningstar, Inc. discovered in a 2020 study that there is “no performance trade-off” between environmentally sustainable funds and the overall market. According to the study, “the majority of sustainable funds have outperformed their traditional peers across multiple time horizons.”
How Can You Tell if a Green Fund Is Long-Term?
Each fund invests in a basket of securities that represents a cross-section of the market. Prospective investors should first examine the securities listed in the fund’s assets to determine if it is sufficiently sustainable. Furthermore, some research firms, such as Morningstar’s sustainability rating or State Street’s R-Factor, may provide independent evaluations.